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$5 Crude Could Put Canada’s Oil Sands Out Of Business

Over the last few weeks, the higher breakeven costs for oil and the lack of sufficient takeaway capacity has come back to haunt Canada’s oil patch. Two months ago, the Canadian Association of Petroleum Producers (CAPP) was expecting upstream capital investment in Canada’s oil sands to grow this year from 2019 for the first increase in capital expenditures in five years due to “a more competitive economic environment,” thanks to new policies of the Alberta government.

It took just two months of a ‘black swan’ global event not only to wipe out any competitive environment but to send Canada’s oil industry fighting for its life, again, just five years after the previous oil price crash from which the industry had just recovered.

Due to the price war and the demand plunge in the pandemic, the price of Western Canadian Select (WCS), the benchmark price of oil from Canada’s oil sands delivered at Hardisty, Alberta, is US$5 or less these days, pushing all producers out of the profitability range and raising the question: Will Canada’s oil sands industry make it through this price slump?

The current disastrous state of the market for Canada’s oil raises another, existential question: as calls for climate action grow, how many investors still believe that higher-cost crude—such as Canada’s heavy oil—can compete economically with the low-cost barrels from Saudi Arabia?

Investors Fled Oil Sands Even Before The 2020 Oil Price Crash

After the previous crash and the subsequent downturn, international oil majors pulled out en masse from oil sands operations, divesting their Canadian businesses to the large local companies. The exodus continued even when international oil prices were more than double the current levels because of pipeline shortages that weighed on Canadian oil prices.

Related: The First Victims Of The Oil Price WarThis time around, the record low prices for Canada’s oil combine with a record decline in oil demand domestically and in Canada’s key, and almost exclusive, export market—the United States. Oil prices in Alberta have slumped so low that a barrel of crude now costs less than the cost to ship it to the U.S. market, which doesn’t need it now anyway because of lockdowns and stay-at-home orders.

Production Cuts Are Coming…

The short-term damage for Canadian oil sands operators will come in the form of substantial financial losses and production reductions. According to Tudor Pickering Holt & Co analyst Matt Murphy, cited by Bloomberg, around 340,000 bpd of thermal oil sands production, or 20 percent of current output, could be shut down due to the unsustainably low oil prices.

According to Wood Mackenzie, the costs in Canada’s oil sands are at the upper end of the curve, even if international benchmark oil prices weren’t so low. WoodMac’s estimates of short-run marginal costs (SRMC) – that is, operating costs plus taxes and royalties – show that the oil sands need “an unenviable US$45/bbl Brent, on average, to cover the cost of production before capex. If Brent averages US$35/bbl for 2020 we expect corporate cash flow from the sector to be US$17 billion in the red.”

However, shut-ins in the oil sands would be a lot more complicated than in other oil production areas, so the sector will first try to slash costs, then consider shut-ins, WoodMac said.

…And So Is Recession

The low oil prices and the coronavirus pandemic will plunge every province in Canada into recession this year, RBC said in a note last week. The heart of the oil industry, Alberta, will be hit the worst, and job losses in the sector will be 2-4 times higher than in 2014-2016.

“The combined losses in these two provinces [Alberta and Saskatchewan] are likely to be in the order of 200,000 – 20% of the overall hit to employment in the country,” RBC said.

“With the economy already on precarious footing, the added shocks of the recent rail blockade protests, the arrival of COVID-19, and a collapse in oil prices have brought the country to the brink of recession,” The Conference Board of Canada said in its Canadian Outlook Summary Spring 2020 this week.

The board expects Canada’s real gross domestic product (GDP) to grow by a mere 0.3 percent in 2020, before bouncing back with a 2.5 percent growth in 2021.

“The Canadian economy is reeling as the impacts of the COVID-19 pandemic ravage consumer and business spending and cratering oil prices have put a halt to the expected rebound in the energy sector,” the board said.

Long-term Prospects

Beyond the current crisis, which put an abrupt end to the oil and gas industry’s recovery, Canada’s oil sands face the existential threat of becoming sidelined on the oil market, where lower-cost producers have the economic advantage to continue supplying the world with oil amid growing calls for decarbonization.

Environmentalists and proponents of electrification of transport and the energy transition are calling for the end of federal government bailouts to the Canadian oil and gas industry.

Alberta’s government sees the oil sands sector as ‘too big to fail,’ and the federal government of Canada probably sees it that way, too, especially with the massive job losses expected in the coming weeks and months.

Yet, a second major crisis in Canada’s oil in just five years could see some investors bail out on the oil sands forever.

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